5

Challenges Undermine Rare Earth Elements

For the past few months, we've heard about the incredible demand for rare earth elements outstripping constrained supply, after China cut back on exports. But there are a few elephants in the room keeping some investors skeptical of the space, including myself. One of those elephants reared its ugly head last week, when Toyota Motor (NYSE: TM) announced that it would look for ways to build hybrids and electric vehicles without rare earth elements.

Rare elements have been riding a couple of myths to higher stock prices over the past six months. One is the thought that demand will only increase and that substitutes are unavailable. Another is that the supply/demand curve doesn't have a breaking point. But when prices get high enough, manufacturers will look for alternatives.

Rare earth stocks feeling the painSky-high rare earth prices have pushed Molycorp (NYSE: MCP) , Avalon Rare Metals (AMEX: AVL) , and Rare Element Resources (AMEX: REE) on a ride higher, but their charts have begun to look like the apex of a roller-coaster in recent weeks. Over the past week alone, Rare Element Resources is down 19.1%, and Molycorp has taken a 17.8% haircut on worries that prices won't rise forever.

Molycorp in particular is starting to feel the pressure to keep other suppliers at bay. The company is trying to get federal loan guarantees to support its expansion, and it's lobbying against competitors' attempts to fast-track environmental assessments. It may be in our national interests to expand rare earth mining, but Molycorp isn't keen on the idea.

If Molycorp really thought prices would stay high and demand would continue to rise faster than supply, why would it go to such lengths to stifle its competition?

As I warned earlier this month, rare earth stocks face many headwinds as supply increases outside of China. Now that one big buyer of rare earths is bringing demand assumptions into question, investors have a little more to think about.

Interested in reading more about Molycorp? Click here to add it to My Watchlist, which will aggregate all our Foolish analysis on this stock.

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

I hope you noticed that while the REE stocks have slowed the actual price of the REE"s themselves are continuing up. That story on Toyota makes me laugh, do you really think toyota has any chance in hell of brinign a new engine to market in the next 10 years that would be REE free?

Jeff Makarewicz, Toyota's VP for Materials Engineering, said that creating substitutes or doing re-designs are "very huge challenges for us, because right now there are no readily-available alternatives".

It is a challenge right now. As a result, prices will rise in the short term. That will be the case for at least the next six months. The question is what happens after that? Lynas is come online, soon after so will Molycorp and a slew of smaller miners.

Even at elevated prices MCP is trading at many multiples of possible sales.

I work in the oil industry and heard the rare earth story fairly early on. Still I didn't get in until a few months ago. Quickly doubled my money (bought

AVL as I couldn't get a good feel for Molycorp with no history) and then got out a couple weeks ago.

If the stocks run up at this point its smoke and mirrors. REE prices are up incredibly from a couple of years ago and to expect these prices to continue past 2 years is a pipe dream as alternate production comes online.

There was a good analysis of all the REE companies that suggests given their production targets they are overpriced already. It was a nice run but the stocks are priced for all the good things that can happen.

I hate to make my ignorance known, but I have no idea where to turn. I invested heavily in AVL and in REE just after the major upturn. I held on after the turn down began, thinking within time it would turn up once again. At this point I will lose considerably if I sell, but realize I could lose it all if I don't. I'm beginning to doubt the intelligence of my 'hanging tough'. Can anyone give me some guidance?

Hanging Tough is not an investment thesis. Sometimes you need to cut your losses. Diversity helps ride out sector challenges. Market corrections sometimes last 2-10 days and sometimes they help establish resistance levels and things move upward again. Rare Earths, (or any equity that has moved as fast) will have a much lower floor as investors who got in early will jump out to protect profits.

In particular, I think you backed the wrong Rare Earth plays to ride things out. AVL and REE are too far from production and too many things can happen in the long run.

It's your money and your risk tolerance, but based on your question, I think you'd do better scaling back. Good luck.

PS. I'm not a bashed of RE. I'm pro-Lynas and I think that MCP could have some value after the expiration plays through if an appropriate correction comes. The key is as this article and others on Fool and other places point out. While demand will grow, (and I agree the Toyota article is speaking of solutions in YEARS), it will not grow enough to absorb the supply. The first few non-China company's hitting production will help keep prices stable. China could even flood the market once they can't protect their monopoly anymore to push new company's down.

According to the USA Department of Energy in any case scenario there shall be critical Rare Earth shortages for the next 15 years. Particularly critical for Dy Tb Y Nd Eu.

Page 72 identifies only 7 Non Chinese companies in Rare Earth Production by 2015: Alkane Lynas and Arafura in Australia, Great Western and Avalon in Canada, Molycorp in the USA and Dong Pao in Vietnam.

See USA Department of Energy summary and full reports, and Center for Strategic and International Studies (CSIS) video presentation links:

Zhang Anwen a leading Chinese government advisor and Deputy Secretary General of Inner Mongolia Rare Earth Guild who in Beijing conference Spring 2010 said:

“Foreign countries should calmly and logically think about this and develop their own mines for their own needs. Our (China) resources are diminishing and we (China) need these minerals for our own use.”

With honest, timely and transparent government communication, the Non Chinese REE mining and manufacturing industry could have risen to the challenge of potentially providing all of the Non Chinese REE supply needs.

Sudden. Permanent. Game-Changing. Earth-Shaking.

Permanent decisions about Chinese REE exports have happened.

The Non Chinese world needs to come to grip with the New Reality:

How to find and fund Non Chinese REE mining and manufacturing sources for all Non Chinese demand?

Let me explain the change that has happened:

"China and US shoot satellites in standoff" Telegraph Group Ltd. UK (See Links)

Dates: January 2007, February 2008, January 2010, February 2010.

Did these international incidents cause the Chinese to change Chinese REE export policy?

Did the Chinese determine that sharing REE with potential military adversaries is not in Chinese Strategic Interest?

If these statements are true, how permanent is the Chinese REE export ban? Particularly of the scarce and strategically important HREE?

How permanent is the Chinese ban of Dy Tb Y ?

Permanent decisions about Chinese REE exports have been made as a result of this incident?

Obviously there are other considerations, e.g, relative scarcity of materials, self interest in developing their own REE manufacturing sector. As the Chinese move up the technological REE manufacturing chain, they shall consume most if not all of Chinese produced REEs.

Further, China claims that China is now “environmentally” concerned?

These “official” explanations seemed insufficient to explain the drastic change in REE exports and total ban on Dy Tb Y.

Suddenly the earth-shaking game-changing REE world events of the last year make sense.

This conflict extends to the rest of the Western world. For example, China’s fear of Strategic Missle Defense Shield in Japan by the USA.

A major change in policy is often due to a significant incident. Why are we surprised?

Please do not take my opinion as fact for yourself. Please review the maze of documents just released by UK Telgraph. Come up with your own judgements. (Links attached).

Please spend 10 minutes or 10 hours doing your own analysis of the just revealed UK Telegraph documents, and decide in your own mind the permanent consequences to REE Mining/Manufacturing.

The Chinese shall ban most rare earths and certainly any HREE that have military applications. The West shall never again trust the Chinese for vital REE resources.

Yes the REE world is forever changed. Irreversibly. Permanently.

The Non Chinese REE mining and manufacturing world is suddenly called upon to deliver 50 percent of the world’s REE supply.

Impossible REE demands shall be placed on the Non Chinese REE Miners/Manufacturers. Can we deliver? I doubt we can.

Severe pressure shall be placed upon each and every Non Chinese Miner to produce. Currently, only 7 Non Chinese REE miners are expected in production by 2015 (Alkane, Arafura, Avalon, Great Western, Molycorp, Lynas, and Dong Pao of Vietnam).

Personally I doubt that these 7 select companies can replace 50 percent of the world’s rare earth needs, even at current levels.

Perhaps with more warning, more awareness of the 2 February 2011 revelations, our Non Chinese miners could have geared up faster, expanded more rapidly, more money could have been raised, more workers trained, etc.?

We have been living in a world based on old assumptions. China: The Rare Earth Monopolist would be our REE “Mama”. China would provide any shortfall that the Non Chinese miners could not provide in the next few years?

New Reality: Virtually all of the Non Chinese demand needs to be supplied by Non Chinese Mining and Manufacturing companies, i.e., 50 percent of the world’s total use of REEs. Virtually all of the already Chinese banned REE: Dy Tb Y. China has already banned 41 REE manufactured products. How soon!

The progression to a total Chinese REE ban is inevitable and may happen at any time.

Is the Non Chinese world prepared for severe shortages? Shortages that the US Department of Energy said in December 2010 shall last at least 15 years? (See attached link).

China: No safety valve for the world. See Zhang Anwen statement: Video attached.

Solutions happen when actions are taken.

May I ask a question? How can we come to our own personal interpretations, and merge our collective interpretation of the New Reality? What actions can we take? How can we “spread the word” of real shortages, real need to increase Non Chinese REE supply capability?

What obligations do governments have to mitigate potential damage to their National Defense, and potential crippling of businesses?

Is there a true REE crisis? A true emergency?

If there is an impending disaster of supply shortfall, what can we do to make a difference? Individually? Collectively? Individual REE companies? REE companies collectively? REE industry collectively?

The future is in our hands. Our collective hands. We will be judged as an industry by our actions.

Yes these are great opportunities for the Non Chinese REE mining/manufacturing industry, but at the same time severely difficult times ahead even working together.

Can we accomplish a nearly impossible task: fulfilling our call to provide the modern world with a sufficient supply of REE?

Zhang Anwen a leading Chinese government advisor and Deputy Secretary General of Inner Mongolia Rare Earth Guild who in Beijing conference Spring 2010 said:

“Foreign countries should calmly and logically think about this and develop their own mines for their own needs. Our (China) resources are diminishing and we (China) need these minerals for our own use.”